Economic Logic, Too

About Me

I discuss recent research in Economics and various events from an economic perspective, as the name of the blog indicates. I plan on adding posts approximately every workday, with some exceptions, for example when I travel.

Thursday, February 25, 2010

As described in a previous blog post, CEOs are not as expensive to a firm as commonly perceived, and they are are real bargain. Still, you have sometimes to wonder why some CEOs stay in charge despite lackluster performance. Is the board asleep at the wheel? The conventional wisdom is that it is all an inside job. As the CEO selects the board and the board selects the CEO, they all protect each other. And when a CEO really needs to be replaced, he is chosen among the members of the board.

Meg Sato advances that there could be another reason. It is all about rent seeking. The board may have interests that differ from shareholders, and thus wants to appoint or keep a CEO who performs in its eyes, but not in the eyes of shareholders. This happens because the CEO is kind to the board and will minimize the leakage of the surplus of the board.

The way this is analyzed is by model this as a Nash game, where CEO wage, costly CEO monitoring and CEO succession policy (internal vs. external) are determined. Because the board does not internalize the welfare of an outsider CEO candidate, it will tend to prefer an insider and monitor him little. Because CEO skills are perfectly observable ex-ante, such skills matter more in heterogeneous industries, and incumbents or insiders have acquired firm-specific knowledge, heterogeneous industries should have more insider CEOS and and longer CEO tenures. While this paper is purely theoretical, other empirical work confirms this conjecture.